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Private Equity Model Needs To Be Overhauled

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But as asset values have fallen and loans dried up, it looks like the private equity bosses are going to have to take a long hard look at their own operations before they get another chance to gamble on the future of others’.

Candover, the British buy-out fund, last week became the first company to announce a “management shake-upâ€, clearing out its driving force, managing director Colin Buffin, and shrinking its staff from 100 to 41 people.

Write-downs upon write-downs have been pouring out of the big funds as the burden of debt taken on in the boom times begins to sit uncomfortably on a post credit-crisis balance sheet. Among the big hitters, KKR, Permira, Candover, Blackstone and Terra Firma have already admitted sharp drops in the value of their investments.

This is not just a temporary bad spell but an irreparable crash that will change the industry for ever following the biggest boom in post-war history, says Bert Wiegman, founding partner of Langholm Capital, a mid-sized private equity fund.

“It’s game over for the big leveraged deals,†he says. “I don’t think it will ever go back to how it was and there is now going to be a sharp learning curve for those funds that relied on easy credit that will be forced to find a new model.â€

Other industry insiders, such as Jon Moulton, managing director of Alchemy Partners, warned repeatedly before the economic crisis of last autumn about the dangers of the boom years.

So just how bad did things get for private equity and is there worse to come? Their opaque operations make it difficult to gauge how the individual funds have been performing. At the height of the market, they were doubling or even tripling the original money put in by investors over the course of three to five years.

But data from US pension funds, which are obliged to publish details of their investment performance, shows that the outlook for funds set up between 2005 and 2008 has turned increasingly sour.

These are young funds, which would not typically start to generate cash returns for three-and-a-half to four years. But most of the biggest buy-out funds with investments in Britain had declined sharply in terms of value by the end of last year.

The most dramatic private equity battle of 2007 was won by Guy Hands, the founder of Terra Firma Capital Partners. He has already admitted that the value of his prize asset, the record label, EMI, has been written down by €1.5bn (£1.3bn). Calpers, the Californian state pension fund shows that the Terra Firma Capital Partners III fund ended last year down 75pc.

According to the same investment records, Permira’s Europe IV fund, which bought set-top box maker NDS and a stake in TV group ProSiebenSat, had dropped by 61pc. Bridgepoint’s Europe IV fund, the owner of sandwich chain Pret A Manger and clothing retailer Fat Face, dropped by 15pc.

Meanwhile KKR’s 2006 fund, which was the world’s biggest when it was launched three years ago, making a raft of investments in US companies and the UK’s pharmacy chain Alliance Boots, had declined 26pc by the end of last year. Its European Fund II, which includes the high-profile PagesJaunes Group, NXP Semiconductor, ProSiebenSat.1 Media and also Alliance Boots, was down 46pc.

Personally I expect some of these investments to crash and burn, the whole highly leveraged model was completely insane. If the economy contracts it could fast become impossible to cut costs enough to service the debt. Slashing jobs to increase profit was one great way to make them look like financial geniuses but considering there investments have already shed staff probably down to the bare bone, what do you do when you are in financial trouble and can't cut jobs and attempt to rely on potential growth in a recession.

Then add in the fact some of these buyouts have huge bank loans, luckily the banks are in a position to absorb these sorts of losses!!!!

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